It must always be kept in mind that with a variable contract, there can be substantial changes in the cash value, lowering of death benefits, and the policy could even lapse if the investment accounts should drop. A good business executive will always want to know the “down side” before making an important decision, so that he will know his choices in case things do not work out as intended. This same attitude should be held by those who are making investment decisions, including whether or not to purchase a variable policy, and if so, what will happen if the market collapses and investment returns plummet—important and logical questions.
Since the individual is looking at an insurance product, the death benefit that would be available to his beneficiaries in case of his sudden death is of prime importance. If the individual is mostly interested in the return on his investments and seemingly cares little about the death benefit, perhaps they would be better served to invest in mutual funds. However, for purposes of this text, the individual is primarily interested in the death benefit. The best method would be to isolate the death benefit from the cash value, and since it is so important, it should be so isolated by guarantees.
Under a Variable Life insurance policy, the death benefit is guaranteed, so the problem does not really exist. However, under Variable Universal Life policies the policy will be lost if it lapses because of insufficient cash values with which to pay the monthly deductions. The cash value may become insufficient because the subaccounts, in which the premium is invested, have had poor performance, regardless of the premium payments made by the policyowner. As with most insurance problems, there is a “rider” available that can solve the problem—the Guaranteed Minimum Death Benefit Rider (GMDB).
What this rider does is what its name implies. It keeps a VUL policy in force for the initial face amount even if the policy’s cash value is not adequate to pay the monthly deductions.
Wording of this rider will vary by company, but basically the rider guarantees that the policy to which it is attached is guaranteed not to lapse as long as the rider is in effect and the policyowner has made premium payments at least equal to a stated minimum amount. What has happened with the rider is that the VUL policy now has the death benefit guarantees of the Variable Life policy.
Typically, the insurance company will express the required premium as a monthly amount even though the premium required may be paid on other than a monthly basis. The aggregate premium that is paid, less any withdrawals or policy loans, must be at least equal to the sum of the premiums that are required.
Every monthly deduction date, the insurer determines if the total of the premiums paid is at least equal to this required amount. If it is, then everything is fine, but if it is not then the insurer will so notify the policyowner and give him a specified period of time—usually until the next premium is due—in which to provide adequate funds to get the premium up to where it should be.
If the cash value is not sufficient to pay the total monthly deduction charges while this rider is in effect, generally, the insurer will deduct as much as is possible from the cash value and will waive the remainder of the deduction. The waiver will stay in force until the end of the coverage period as applied for in the application.
As stated previously, an insurance company is not an eleemosynary institution, so there is a cost for the rider which is to cover the cost of the guarantee. However, because of competition, the additional cost may be lowered and, it is hoped, eventually eliminated, and replaced with an asset allocation limitation combined with the premium requirement. In other words, by requiring that a policyowner maintain a certain fixed account or money market account allocation (the most conservative investments, obviously) the insurer can minimize its risk that it would have to pay a GMDB guarantee.
The GMDB is not the perfect solution, however, as it requires certain trade-offs, with the most obvious being the loss of some of the flexibility of the premium. The Variable Universal Life policyowner should make sure that the cash value is sufficient to pay the monthly deductions, but the GMDB requires that the policyowner maintain a certain amount of premium payments regardless of the level of the cash value.
In addition to this requirement, the VUL policyowner’s access to the cash value is limited, and policy loans and withdrawals can affect the rider’s guarantee. The total of the premiums paid into the policy (the aggregate amount paid) are reduced by any policy loan and/or withdrawals before it is compared to the total premium required. Therefore, if the policy loan or withdrawal reduces the aggregate premiums to an amount below that that is required, then the policyowner could not take out the policy loan or withdraw funds without jeopardizing the guarantee of the GMDB.
Regardless of these restrictions on cash, value loans, or withdrawals, overall the GMDB rider is of immense benefits to some VUL policyowners. Since they do not have to “worry” about the death benefits or the possible impact of a lower death benefit on his family, the policyowner may accept some market risks that he otherwise would not have taken, sometimes with impressive results. Besides, just the fact that the death benefit is guaranteed is a very important means of reducing the volatility of Variable Universal Life.
Of all of the various methods for a policyowner to manage the value of their policy, the asset allocation procedure has the most effect on the Variable life insurance policy. There are different approaches to asset allocation and they may seem rather technical, however the concepts are really not that difficult and should be understood by those who market Variable life products.
Basically, the asset allocation in variable products is a process of determining what percentage or amount of the assets to be invested by the customer best suits him—taking into consideration his objectives, the length of time that the investments are to be managed (time horizon), and his risk tolerance (as discussed earlier). In effect, the asset portfolio is divided between various classes of assets that best match the policyowner’s objectives and his risk profile so the capital can be protected against negative developments; while at the same time, taking advantage of developments that can affect the assets positively. Assets considered include stocks, bonds, cash, real estate, etc.
Each of these assets—stocks, bonds, cash, etc.—can be determined to have a potential return and a particular level of risk, and it usually behaves in a manner in response to market (and other) changes that are different than the response of other asset classes. Asset allocation is generally considered as the most important decision made by an investor—where to invest the assets and in what proportion—and further, it has a more meaningful impact on reducing total risk than by selecting the “best” investment in any single asset category.
Obviously, assets can be allocated in any percentage that is believed to meet the needs of the policyowner and still stay within the risk-tolerance area of the individual. There are three approaches, one for each aggressive, moderate and conservative investor.
The first two approaches, fixed and flexible weightings, differ mostly by the nature of the proportion of the assets in an investor’s portfolios. It is possible to involve a combination of these two—or all three if the portfolio is large enough—but it is usually more practical just to use one approach.
Simply put, this system uses a fixed percentage of each of the categories of assets (stock, bonds or cash) and they remain relatively stable over time. However, since the asset values fluctuate with market trends, the percentage must be adjusted from time to time to keep the desired fixed percentage allocations. As an example, a portfolio might be 50% stock, 40% bonds, and 10% cash. The adjustments are usually made manually, however they may be adjusted automatically, as described later.
With variable insurance products, the balance of assets can be adjusted as often as quarterly or as infrequently as annually as determined by the policyowner. It should be kept in mind that asset allocation adjustments are made after any major market move. For instance, if the stock market jumps, the example previously quoted could be adjusted to reflect such a move by increasing stocks to 60%, reducing the percentage of bonds to, say, 32% and cash to 8%. However, in order to maintain the asset allocation percentages of the client, the stocks would have to be reduced back to 50%. While the total value of the assets has increased, the percentage remains the same, so the dollar value of the stocks would be reduced—although the overall value has increased—so the bond holdings and the cash would both be increased in value also while still being returned to the original 50-40-10%. An example can perhaps explain this better:
Original portfolio
Asset Asset value Asset allocation
Stocks $100,000 50%
Bonds 80,000 40%
Cash 20,000 10%
Total $200,000 100%
After a drastic stock market increase, now the assets are valued:
Stocks $150,000 60%
Bonds 80,000 32%
Cash 20,000 8%
Total $250,000 100%
Adjusted in keeping with the original intent:
Stocks $125,000 50%
Bonds 100,000 40%
Cash 25,000 10%
Total $250,000 100%
This method of asset allocation is relatively simple as it just reacts to changes in the portfolio classes and automatically rebalances it when investment activity makes it necessary so that the investor will always hold the same percentage.
Flexible weighting is much more flexible, as the name implies, as it involves adjusting the selected weight for each asset in the portfolio at specified times and based upon the market analysis or market timing.
To explain this method better, using the same assets as before
Asset Asset value Asset allocation
Stocks $100,000 50%
Bonds 80,000 40%
Cash 20,000 10%
Total $200,000 100%
For purposes of this exercise, assume that inflation rates are expected to drop, and with such a drop this would usually result in increased (domestic) stock prices. Therefore, the investor may want to anticipate this increase by changing the percentage allocations to expect a greater return in his portfolio. The new asset allocation may look something like this:
Asset Asset value Asset allocation
Stocks $150,000 75%
Bonds 40,000 20%
Cash 10,000 5%
Total $200,000 100%
This system is actually appropriate only for large institutional investors, but it is still noteworthy. This is similar to the flexible allocation system described above, however it employs stock index futures and bond futures, e.g. when stocks are not as attractive as bonds, the stock future are sold and bond futures are purchased, and vice-versa.
This system is rather sophisticated and it relies upon financial models to alert the investor as to the market movement, therefore it relies upon a large portfolio.
While these assets under discussion here consist of stocks, bonds and cash, in reality there are all types of each asset. For instance, stocks can be common stocks, preferred stocks, stocks that are considered as “blue-chip”, international growth fund stocks, etc. Bonds also have different classifications, such as municipal bonds, corporate bonds and US Government bonds. Cash may be in the form of CDs. passbook savings, money market funds, etc.
If the individual is aggressive with his investments, to maximize income, he must be aware that he will have to take substantial risk to accomplish what he wants. Usually the policyowner will not have to access the cash values for 10 or more years to any large degree, and therefore the cash value of the policy should consist of funds that are allocated to the stock subaccount. The lengthy period of time that the funds are invested help to minimize the risks as much as possible.
If the policyowner has a shorter investment period in mind—5 to 10 years—then a moderate growth allocation is in order with stocks dominating the portfolio, but bonds and cash will be larger in proportion than the aggressive portfolio. The moderate investment portfolio is usually more diversified than the aggressive portfolio.
If a conservative growth portfolio is desired, then they should prefer a low turnover portfolio with mostly blue chip securities. This would be appropriate for a policyowner who may need access to his funds for a short period of time—3 to 5 years—and the ultimate goal is nearly always the preservation of the portfolio. Generally stocks are still the predominant investment, but of the blue-chip type.
Under the assumption that the assets are balanced according to the wishes of the policyowner, then when they are “out-of-balance” because of the increase or decrease of any of the assets due to market conditions, then they must be returned to their original balance. In actual practice, automatic reallocation is easy and cost-free.
Market activity can “unbalance” the portfolio so that it no longer expresses the wishes of the policyowner. The preceding example of a portfolio that was out-of-balance because of market changes demonstrates how this is accomplished. This is mentioned again because the next investment strategy discussed is not available with the automatic asset rebalancing.
The dollar cost averaging technique is basic to those who invest regularly, and simply put, when prices are lower more shares are purchased, and when they are higher—fewer stocks are purchased. This, when performed correctly, results in a lower average cost per share for the investor. Perhaps the biggest concern of those who invest in accounts and subaccounts, is that if funds are transferred from one subaccount to another and then the value of the subaccount falls rapidly—this is certainly a legitimate concern. This can easily happen because the value of variable subaccounts does fluctuate—that is the nature of the beast.
What dollar cost averaging can do is make sure that the average cost of purchased shares is lower than the average price of those shares while the market fluctuates. This allows a policyholder to average out the cost of shares during the purchase period, by transferring automatically fixed-dollar amounts from one subaccount to another.
The purpose of dollar cost averaging is to provide the policyholder an average cost per share that is lower than the average price per share over the same period of time as the market fluctuates. It does this by purchasing more units of the subaccount to which the funds are being transferred when the unit value is lower—and conversely, fewer units when the unit value is higher.
This concept can be best explained by the following example: In this example, the policyowner investor transfers $1,000 each month from the bond subaccount to the stock subaccount. For this example, the stock subaccount’s unit value fluctuates as indicated below.
Stock Stock
Transferred Unit Value Unit Value
Jan. 1 $1,000 $8.50 $117.65
Feb. 1 $1,000 $8.00 $125.00
Mar. 1 $1,000 $7.50 $133.33
Apr. 1 $1,000 $7.00 $142.85
May 1 $1,000 $6.50 $153.85
Jun. 1 $1,000 $7.00 $142.85
Jul. 1 $1,000 $8.00 $125.00
Aug. 1 $1,000 $8.50 $117.65
Sep. 1 $1,000 $9.00 $111.11
Oct. 1 $1,000 $9.50 $105.26
Nov. 1 $1,000 $8.50 $117.65
Dec. 1 $1,000 $9.00 $111.11
Total $1,503.31
AVERAGE PRICE PER UNIT $8.08
AVERAGE COST PER UNIT (12,000 ¸ 1503.31 $7.98
Therefore, the average price per unit over the 12-month period was $8.08; the actual cost per unit was $7.98 — $.10 each for 12,000 units equal $1,200 total!
While transfers may usually be made from any variable subaccount to any other account, dollar cost averaging transfers from the fixed account are not allowed.
As a general rule, there is no cost to the policyowner in respect to dollar averaging, and the policyowner can use this strategy over and over. As stated above, automatic rebalancing and dollar cost averaging may not be implemented at the same time.
Many variable insurance products allow the “interest-sweep” feature where the insurer reallocates the interest credited to the fixed account to one or more of the variable subaccounts. If the interest is to be “swept” into one or more account, the policyowner must indicate the subaccounts to which the interest should flow, the percentage allocation to each of the subaccounts and the time that the interest sweep is to occur (monthly, quarterly, semiannually or annually).
The benefit to the policyowner is similar to the dollar cost averaging benefits, as the policyowner uses the interest that is credited to the fixed account and uses it to purchase variable subaccount units. The funds that are reallocated using this method do not vary greatly, fewer units of the variable subaccounts are purchased when the value is higher and, conversely, more units of the variable subaccounts are purchased when the unit value is lower. Therefore, the cost per share is lower than the per share price in a market that fluctuates with the result that the total value of the policy is likely not be much affected by any negative movements in the market.
“Living benefits’ is a term that is used to describe the use of life insurance benefits while the insured is still alive. In today’s atmosphere, this dual function of life insurance is most applicable because of the cash values and the buildup of these values using variable products. The traditional whole life policy provides living benefits as well but not at the rate of growth of the variable policies.
It must be kept in mind that these policies are more expensive than term life insurance; therefore, the proper clients for these policies are those that have interest in savings as well as having death benefits. The most desired result of living benefits—considered by many as “forced savings”—is in saving for retirement.
Most Americans look upon retirement income as a combination of Social Security benefits, whatever savings has been gathered and invested, and perhaps a pension from an employer. There is still a question as to whether Social Security will be around at retirement and if it is, what form will it take? With the baby-boomers starting to gather Social Security benefits, the source of funding is questionable, but still, the American people seem to want to just avoid talking about it. However, there are growing bodies of citizens who question whether it will be there when it is needed, and these are the ones that will make an effort to be more self-sufficient... Life insurance plans can create a sense of security by the policyowner knowing that if he dies prematurely, his family will be taken care of, and if he lives to a ripe-old-age, there will be funds available to him so that he can enjoy his golden years.
The modern American is also faced with the threat of company-paid pension plans not being there when needed, in face of all of the mergers and acquisitions, plus bankruptcy of so many huge corporations—General Motors, for instance.
This section discusses one way of saving for retirement while the insured is alive and also providing for the possibility of premature death and eliminating the problem of destitute family survivors. This is, of course, the use of life insurance supplementing retirement income, using the tools of the various forms of life insurance. While annuities are an insurance vehicle that is designed specifically for the purpose of providing retirement income, this discussion focuses on the additional security of providing a death benefit. Other courses can discuss in detail the use of annuities and variable annuities.
NOTE: The creation of cash values has been previously discussed, however in order to better understand the used of cash values specifically for retirement, some of the information may be repetitive.
Cash values of a life insurance policy are a source of funds to which the policyowner has access, and they may take the form of either policy loans or cash withdrawals.
There are differences in the process of obtaining these funds, but permanent life insurance cash value is derived from two sources: premiums for the policy that are paid by the policyowner; and/or interest credited by the insurer to the cash value account of the policy.
Since these two methods differ between variable and traditional products, the following discussion not only explains how cash values are decided, but also it demonstrates the flexibility of the modern Variable life policies as they relate to providing retirement funds.
The policy cash values of whole life insurance policies are a result of the level premium system as was discussed in detail earlier in this text. The early premiums are in excess of what is needed to cover a death claim that should occur during this period. These excess premiums create a fund, known technically as unearned premium reserve. This reserve can be drawn upon later in the policy duration when a death claim is more than the total of the premiums that have been received. This reserve is approximately equal to the cash value of the policy.
The cash value in a Universal Life Insurance policy is created much as with a whole life insurance plan, i.e. the policyowner makes premium payments, but with the ULI policy, the insurance company deducts a certain percentage—the expense factor—and credits the remainder to the cash value. The insurer also deducts the cost of insurance from the cash value, and if the policy is a declared-rate policy, that interest is credited to the cash value. The cash value will increase if the premiums that are paid and the interest that is credited to the policy are more than the policy costs.
When the insurer receives the premium and deducts the expense charges that are related to the premium, the balance is credited to the cash value each month on a specified date, called either the monthly deduction date or monthly anniversary day. At that date, the insurer will add the interest to the cash value at the current interest rate used for this purpose, and the monthly deduction will be subtracted at that date. Therefore, the monthly deduction is the total of the monthly cost of insurance and the monthly cost of any additional benefits that may be provided by a rider.
This can best be explained by using an example.
The policy is a Universal Life policy with a face amount of $100,000, with a cash value in that policy at the last monthly deduction date of $10,000. The premium is $600 which was made since the deduction date. The expense factor is 4% and the insurance company is crediting 6.5% annually on its Universal Life policies. The insured is 60 years old, so the current cost of insurance is .6667.
$10,000.00
plus 576.00
minus 60.00
plus 68.35
Total cash value on current date: $10,581.35
The insurance company credits interest to the cash value in a Universal Life insurance policy and that contributes significantly to the growth of the cash value.
The amount of the contribution is a minimum contribution that is stated in the policy, however in actual practice the actual amount will be higher—the current rate—depending upon the economy
Just before Universal Life was introduced in the early 1970’s, interest rates were often double-digit, even though the credited interest rates were in the 3-4% range. The difference between the credited interest rates and the current rate is excess interest.
The current interest rate is determined by the Board of Directors of the insurer, which means that since it is at their discretion, it may fluctuate widely but usually it reflects the general interest rates in the economy. However, the current interest rate is highly competitive as the success of the company’s Universal Life insurance sales may hinge directly on the current interest rate, with the result that the current interest may be a little higher than the common interest rate used in other businesses.
While the insurer’s mortality rate and actual expense ratio may make for good reading for investors in the life insurance company and for financial analysts, the consumer usually has little interest in those figures—mostly because they have no readily available numbers to compare them to—while, on the other hand, the comparison of Co. A’s current rate and that offered by Company B is easily ascertainable and understandable. True, the current rate is not the entire picture when comparing ULI policies, but it does provide an easy comparative analysis.
As explained in detail earlier, Variable Universal Life (VUL) policies are as flexible as Universal Life products, but the principal difference is in the way that the cash value grows. With VUL policies, cash value depends entirely upon the subaccounts in separate account as determined by the policyowner from the offerings under the VUL contract.
The separate account is the place where the Variable life policy’s net premiums go and it has no relation to the assets or liabilities of the insurance company. The insurer accounts for these funds in their general account—, which means that the insurance company’s assets are not available to guarantee any result of the separate account. On the other hand, the separate account funds are not available to the creditors of the insurer. The separate account is just that—separate—and its performance relies entirely upon the fortunes of the separate account and nothing else.
Previously, the separate accounts were discussed and were broken into stocks, bonds and cash (money market fund), which were all that were available when Variable life was first introduced. Investors wanted more, and many of them had experience with mutual funds, so they wanted the Variable life separate account to offer similar options so that their experience would approximate the experience of mutual funds. Today, because of the demands of the consumers, separate accounts typically offer various types of investment options.
For the consumer their separate account can provide investment expertise through company-managed options and access to funds that are managed by experienced and highly regarded mutual fund managers.
Irrespective of the number and type of options, these investments are categorized by (1) capital appreciation, (2) income, or (3) growth and income.
In addition, the policyowner may also decide to allocate some (or all) of his net premiums to the general account of the insurance company. Cash values that are allocated to the general account of the insurer receive interest at the rate that the insurance company receives. Usually, the interest is allocated at the same rate that the insurer is crediting on its declared-rate Universal Life policies.
There can be several reasons for an insured to use the insurer’s rate that is credited to its Universal Life policies, such as a policyowner not being familiar with the workings of mutual funds—or in some cases, with any investment vehicle. Others may not want “to fool with it” for whatever reason but often it is a situation where the individual may have many other investments and he may just want to keep some money separate. Of course, it could be that the policyowner is just more concerned with the death benefit.
Policy loans as they pertain to whole life insurance have been discussed earlier with some reference to the Variable life products. Variable life products have their own uniqueness. Generally, policy loans are available with all forms of permanent life insurance, including variable Universal Life, in amounts of 75% to 100% of the cash surrender value of the policy.
Policy loans are received tax free by the policyowner, such amount will be paid back with interest, by either paying the insurer the loan amount or subtracting the amount from the death claim.
There are additional limitations in the majority of Variable life insurance policies because of the varying feature of the cash value. For instance, it is possible for cash values to decline because of the decrease in the value of the underlying investments in the separate account; therefore, it is possible that a policyowner could have a loan outstanding that is more than the surrender value of the underlying policy. Because of this possibility, insurers place limits on the amount that can be borrowed as a policy loan.
The amount that can be loaned with variable policies is usually limited to approximately 75% of the cash value. Often this limitation is on the first 2-3 years and then it can be increased to as high as 90% at the end of the policy period with some policies.
It should be remembered that in addition to these limits imposed by the insurer, the policyowner must keep sufficient funds in the cash value account so as to cover the usual monthly deductions made by the insurer.
The mechanics of a Variable life policy loan is that the loan amount is transferred to the general account of the insurer from the separate account. The subaccounts that could be used for the transfer of these funds depend upon the instructions of the language of the policy. Often policy loans are transferred from the separate account subaccounts for a policy loan, using the same proportion as the policyowner’s allocation of net premiums to the investment divisions. For instance, if the policyholder designates 70% stock, 30% bonds, and 20% cash, then that is the formula for transferring funds from the subaccounts.
Since the funds are then transferred to the insurer’s general account, these funds no longer participate in the activity of the separate account—negatively or positively.
The interest rate credited to the general account will be specified in the policy, and the amount of the loan accrues loan interest, which may be at a fixed or a variable rate, depending upon the wording in the policy.
As with all policy loans, a policy loan from a variable Universal Life policy reduces the value of the policy as both the cash value and the death benefit are reduced by an amount that is equal to the policy loan, plus accrued interest.
For cash values in the account that are drawing interest, insurers sometimes pay a lower rate on the amount borrowed against than on the amount not borrowed. For example, assume there is $10,000 in the cash value account. The policyowner borrows $6,000. The insurer might pay only its guarantee interest rate of 4% on the $6,000 borrowed, but continue paying the current interest rate (guaranteed interest rate plus excess rate) of 8% on the remaining $4,000.
Other insurers may treat a UL loan as a so-called wash loan because the interest rate the borrower pays and the interest rate the insurer pays on the cash value are the same, so each rate "washes out" or equalizes the other.
For example, suppose the current rate the insurer is paying on the cash value account is 7% and the policy loan rate 6%. With a wash loan, the 7% rate would be reduced to 6% to match the loan rate.
FFor tax purposes, where withdrawals are allowed, withdrawals are usually free of tax up to the tax basis; withdrawals in excess of the tax basis are taxed.
Sometimes the policyowner wants to have access to his cash for a longer period of time and wants to avoid the payments of the interest charge. This can happen for a variety of reasons, including the “whoops” factor where the policyowner misjudged how long he could have his money “tied up”. One of the advantages of Universal Life and variable Universal Life is that withdrawals can be made (not allowed on whole life policies). When one thinks about it, this makes sense for variable products because whole life insurance cannot allow the cash value to be diminished by a withdrawal as the whole contract is based upon guarantees. Actually, as explained previously, policy loans are not “withdrawals” from the cash value of a whole life policy, but are, in fact, loans from the insurer.
On the other hand, with Universal Life and its “unbundled” features, the cash value is not a guaranteed amount, therefore withdrawals can be allowed.
When a partial withdrawal of funds is made from a variable Universal Life policy, the question arises as to which subaccount the funds should come. The determination is strictly that of the policyowner who so specifies. Sometimes, for whatever reason, the policyowner does not make the determination, in which case the insurer takes the funds from the subaccounts in the same proportion that assets are invested (as with policy loans).
Which is best, policy loan or withdrawal? The determination would depend upon the policyowner and his needs, but the principal determination would hinge on whether he is planning on using the money and then returning it to the policy. A withdrawal is final, even to the point that if the policyowner makes a withdrawal and then decides to “repay” this amount, the payment would be treated as a premium payment and subject to any applicable premium charges—however, this is no “biggie” as it usually is some small amount, such as $25.
In respect to limitation, policy loans have limitations, and so do withdrawals, but the withdrawal limitations are more demanding and they relate to the amount of the withdrawal, how often they may be made, and the charges that will be made for any withdrawal. The good news is that these restrictions have gradually been reduced—or, in some cases, eliminated—but many insurers still limit the number of withdrawals permitted in a year.
The maximum amount that can be withdrawn is rather straightforward, i.e. the maximum is the cash loan of the policy less any loans that may be outstanding. Conversely, the minimum is usually something in the $300 - $500 range. The reason that there is a minimum is an attempt to restrict the number of small withdrawals because of administrative expenses. Since a withdrawal is basically partly a surrender, a charge may be inflicted (providing another limitation). A withdrawal decreases the cash value of a policy on an equal basis.
There are also limitations on some death benefits in case of a withdrawal: while the death benefit of Option A would not be affected, Options B and C death benefits are reduced in the amount of the withdrawals, dollar-for-dollar.
There actually are certain benefits to policy withdrawals, as the policyowner may access funds from the cash value and not have to pay interest on the “loan”. One thing to keep in mind is that the withdrawal is considered as a return of the policyowner’s cost basis for tax purposes, provided that the policy is not considered a modified endowment contract (MEC) as previously discussed. Therefore, it avoids any income taxation if the amount withdrawn does not exceed the total of the premiums that have been paid by the policyowner.
F For tax purposes, any withdrawal reduces the policyowner’s cost basis.
STUDY QUESTIONS
1. For an individual considering the purchase of a variable insurance contract, it must be assumed
A. that the individual is more interested in income than in protection.
B. that the individual is primarily interested in the death benefit
C. the prospect knows the product very well, so little definition is required.
D. that they already have considerable investments in other vehicles.
2. Under Variable Universal Life policies,
A. the death benefit is guaranteed.
B. the policy could lapse because there is insufficient cash value to pay the monthly deductions.
C. the monthly deductions can be paid with dividends, so there is practically no chance of the policy lapsing because of insufficient cash value.
D. the cash value always contains ample funds to provide the death benefit.
3. When a policyowner purchases a guaranteed minimum death benefit rider,
A. the variable policy becomes a whole life policy.
B. the VUL policy now has the death benefit guarantees of a Variable life policy.
C. in many cases, the extra premium is so high that the policy is lapsed.
D. the Variable life insurance policy becomes a variable Universal Life insurance policy.
4. If the policyholder purchases a Guaranteed Minimum Death Benefit Rider, the rider requires
A. the policyowner to show evidence of insurability annually.
B. that the policyowner maintains a certain amount of premium payments, regardless of the level of the cash value.
C. a maximum cash value growth.
D. the fifth dividend option be exercised.
5. Of all of the various methods for a policyowner to manage the value of their policy, the method that has the most effect on the Variable life insurance policy is
A. asset allocation.
B. guaranteed minimum death benefit rider.
C. annual redetermination.
D. to establish a trust.
6. In asset allocation, an allocation that is based on maintaining a fixed percentage of the portfolio in each of the 3 categories of assets, is
A. Fixed Weightings.
B. Flexible Weightings.
C. Tactical Asset Allocation.
D. Variable Reallocation.
7. A investing technique that provides that when prices are lower, more shares are purchased, and when they are higher, fewer stocks are purchased, is
A. Flexible Weightings.
B. Tactical Asset Allocation.
C. playing the futures market.
D. Dollar Cost Averaging.
8. An “Interest Sweep” feature of a variable contract is
A. when the insurer reallocates the interest credited to the fixed account to one or more of the variable subaccounts.
B. when the interest rate is the same for stocks, bonds and cash investments.
C. when the asset allocation is the same for stocks, bonds and cash investments.
D. when the insurer assumes a certain interest rate for the premium of a variable product, and the premiums will be the same for all similar products.
9. The difference between the credited interest rate and the current rate on UL policies, is
A. never more than 2% by law.
B. excess interest.
C. superfluous interest.
D. taxable to the policyowner at capital gains rates.
10. When withdrawals are allowed on variable contracts, they are usually
A. free of tax on any amount.
B. free of tax up to the tax basis, taxed for amounts in excess of the basis.
C. taxed for amounts up to the tax basis, free of tax for amounts over the tax basis.
D. heavily taxed as any increase in cash values since policy inception then becomes taxable.
ANSWERS TO STUDY QUESTIONS
1B 2B 3B 4B 5A 6A 7D 8A 9B 10B